Why Gold is About To Power Higher to Complete a Big Rally
David Banister- www.MarketTrendForecast.com
The gold bull has been moving in very reliable Elliott Wave and Fibonacci patterns for many years now, but once in awhile the waters get a little murky for sure. Recently we have seen a fair amount of volatility near year end as position squaring and year end machinations take hold. With that said, it does appear that Gold should be poised to power higher near term, and I’m looking for a completion to a 5 wave rally that began from about $1,040 per ounce in February of this year.
Over the past several weeks, I see a clear Fibonacci trading day relationship on Gold’s swings from pivot highs to pivot lows. 8 days of correction, 13 days of rally, 8 days of correction is the recent pattern over the past 5 weeks or so. Below is a chart outlining these crowd behavioral based patterns that I rely on for both my trading service and market forecasting services. You can see the clear relationships, confirmed by the stochastics indicators at the tops and bottoms as well:
Based on the recent patterns, I believe we completed a minor wave 3 from the February bottom at $1424 a little over 5 weeks ago, and had a shallow period of 8 days to complete a wave 4 to $1,330. Now, we are in the final 5th wave up pattern to complete an entire 5 wave move from February of 2010. In the near term then, I’m expecting a pretty strong rally from this recent $1365 area to at least $1,480 per ounce, and eventually a good shot at completing the structure at $1525 ranges. Short term, we should begin a wave 3 up here, followed by a 4th wave correction, and then a final and terminal 5th wave. Below is a multi- month weekly chart view of where I see us heading and where we’ve been.
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Market pundits and prognosticators are all worried as to whether Santa is going to deliver presents to Wall Street this year. While we have seen the S&P 500 reach new highs in December, the S&P 500 is facing a wall of resistance around the S&P 1250 area. Based on price action today, Santa may not be coming to Wall Street in 2010.
Market participants are aware that the holiday season tends to usher in light volume and declining volatility historically. When volume is light and volatility is declining there is generally a bias to the upside as equities typically grind their way higher. In the recent past, Santa has come to Wall Street and delivered gifts of good fortune to those that were heavily invested in the domestic financial markets.
Unfortunately Santa may not deliver presents to Wall Street this year as apparently one sector in particular has behaved poorly. If the financial sector does not start behaving, Santa may not come to Wall Street at all in 2010. Apparently Santa and Mr. Market are good friends as they both like to watch the financial sector closely.
The action in the KBW Banking Index (BKX) recently has not been inspiring. In fact, the action suggests that the financial sector may potentially be putting in an intermediate to longer term top. Before coming to any conclusions, we need to watch the price action in the financial sector play out before jumping in on either side. As Minyanville founder Todd Harrison often writes, “as go the piggies, so goes the poke.”
Essentially what he is saying is that without the banks participating in a rally, the broader market will have limited upside. If the banks are sold heavily, the broader market is likely to follow. As can be seen from the chart illustrated below, the BKX tested recent highs and has failed on its first attempt to breakout. As most traders are already aware, every time a level is tested it becomes weaker so we will be watching to see if this level is tested again in the near future. Illustrated below is the daily chart of the BKX banking index:
Price action in coming days will help us determine if this is just a pause before a breakout or whether the BKX index is telling us that prices are headed lower in the financial sector. If the KBX, XLF, & KRE start to breakdown, as traders we should anticipate that the broad markets such as the S&P 500 will likely follow.
The Tuesday morning session saw the S&P 500 climb higher, only to be sold off in the afternoon eventually closing up around 1.13 points (+0.09%) while the Dow Jones Industrial Average rose 47.98 points (+0.42). However, the Financial Select Sector ETF $XLF closed the day down (-0.89%), the KBW Banking ETF $KBE closed down (-1.55%), the KBW Banking Index $BKX was down (-1.52%), and the KBW Regional Banking ETF $KRE closed up (+0.28%). While the broader markets were in positive territory, the banks for the most part were under suspicious selling pressure.
The S&P 500 weekly chart indicates that we are approaching some major overhead resistance levels. Is the financial sector trying to warn us of potential downside? Is the rollover in the banking sector a head fake before they break higher and the S&P 500 follows suit? It is impossible to know for sure at this point, but I for one will be monitoring the financial sector quite closely for any possible clues about possible direction on the broad domestic indices.
Is Santa going to put a lump of coal in Wall Street’s stocking this year? That question will be answered in due time, but for now investors and traders alike should be watching the banks as the broader markets will struggle to rally without their participation.
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The past week has been interesting to say the least. Gold is trying to find support while the SP500 grinds its way higher. Let’s jump into the charts and analysis to get better feel for what I feel is happening here.
Gold 4 Hour Chart
As you can see from the chart below gold has formed a possible double top. The fact that it made a higher high is actually a bearish sign for the intermediate term 1-3 weeks. When we see a higher high getting sold into with big volume it typically means the big money is unloading large positions into the surge of breakout traders and short covering that occurs when a new high is reached. Following the big money is very important to keep an eye on as it can warn us of possible trend changes before it occurs.
The current selling volume is not exactly a healthy sign if you are looking for higher prices in the near term. If this pattern breaks down I would expect $1340 to be reached very quickly.
Keep in mind gold it in a strong up trend still. Shorting is not the best play in my opinion. I prefer to see pullback which washes the market of weak positions then jump on the long side for another bounce/rally.
SP500 Market Internal Strength – 10min, 3 days chart
I watch these charts to get a feel for the overall market strength on a short term basis. The top chart shows the SPY etf breaking above a resistance trend line on Friday afternoon. This occurred on light volume meaning it is mostly likely a false breakout and Monday we could see a gap lower at the open or a pop & drop. The two other indicators are reaching an extreme level which normally tells us a pullback is due in the next 24-48 hours of trading. The question is, will us just be a bull market pause or will we get a decent pullback.
The red indicator in the top chart and the red indicator levels on the charts below that help us time the market as to when profits should be taken or to tighten our stops if we have any long positions.
The broad market is still in a very strong uptrend so moving stops up and buying on oversold dips is the way to play it.
Weekend Market Analysis Conclusion:
In short, both gold and the stock market are in a bull market (uptrend). Trying to pick a top to short the market is not a good idea. Instead I am looking for an extreme oversold condition to help reduce downside risk before taking a long position.
The overall strength of the market (SP500 and Gold) I think are starting to weaken but in no way am I going to short them. We continue to buy dips until proven wrong because indicators can stay in the extreme overbought levels for a long period of time. Generally the biggest moves happen in the last 10-20% of the trend.
If you would like to get these weekly reports and my trading tips book free be sure to visit my website: www.thegoldandoilguy.com/trade-money-emotions.php
In the past few weeks I have made the case that gold might be nearing a correction. I understand that people get defensive regarding gold (no pun intended), but I do not think vulgarities should be expressed towards someone who is pointing out the overbought nature of the daily and weekly charts. It seems any time that I discuss a possible pullback in gold I place a giant target on my back for people to make nasty public comments or send me hateful emails which in some cases I find particularly amusing. To each his own, but something tells me this article will be as well received as an oral reading of the history of the Illuminati at a Christian Christmas celebration.
Before you all rush to berate me for saying gold may go through a mild correction, read this paragraph before you take my work and my name through the proverbial mud . . . AGAIN. Before discussing why gold may go through a short-term correction, I would point out that in the long term I believe gold is in a secular uptrend that could last much longer than many market pundits or traders might prognosticate.
I do not hold myself out to be an economist, but it appears to me that there are several catalysts looking towards the future that likely will give gold a boost. Unfortunately, the reasons gold could continue rallying are not economically pleasant and certainly not exciting to discuss as by now they have been beaten into our psyches. Instead of pounding the table about all of the various reasons investors should own gold, I am going to focus on a potential opportunity to buy gold at lower prices.
Based on a variety of technical indicators and analysis paired with some fundamental opinions, a trader could make the case that gold is in need of a downward price correction. Gold has been purchased with strong volume for more than a year as a result of several reasons. When looking at a weekly chart of the gold ETF GLD it becomes apparent that the shiny metal is overbought and in need of a pullback, or at a minimum some healthy consolidation.
As can be seen above, gold remains in a strong uptrend and price is well above the 50 period moving average. In fact, the 50 period moving average on the weekly GLD chart has not been tested since April of 2009. The long term trend remains bullish, but as stated above stated above not needed here a pullback is possible.
If we take a look at the GLD daily chart we notice the same long term uptrend that that is needless here we witnessed when looking at the weekly chart. In contrast the daily chart does show potentially bearish formations beginning to work. While the bearish formations patterns, too close previous use of formations may fail or may turn out to be totally false why totally, just use false, it is strong enough on its own based on future price action, at this point a double top formation is possible as is a head and shoulders pattern. This is not to say that GLD cannot grind higher because the weekly chart looks quite strong, but the daily chart is at least posting a warning that lower prices or at least a period of consolidation may be coming to fruition in the not-so-distant future.
While I am expecting a meaningful pullback or correction at some point, I do not believe that gold is going to crash lower. In fact, I am viewing the possible correction in gold as an excellent potential long entry. Clearly traders could look to purchase GLD around the 50 period moving average on the daily chart ($133.06) and then add to the position if the neckline is tested. I do not believe that price will get to the neckline, but if it does I expect that level to hold and a new rally to take shape. Until gold gets below the 50 period moving average on the weekly chart, it remains in a technically constructive uptrend.
There are a variety of ways to purchase GLD if an equity trader wanted to leg into the trade at a variety of price targets. One strategy would be to simply accumulate partial positions at predetermined price targets. When considering entering a longer term position, investors and traders should formulate a plan and then trade that plan. Through the use of a trading plan, the trader can remove emotion from the subsequent purchase(s) while managing risk.
For those who would like to use options to acquire GLD common stock, the easiest strategy would be to sell cash secured naked puts. Secured naked puts do not require significant option trading experience and most option brokers will allow relatively inexperienced option traders to use this strategy. Each option contract represents 100 shares of GLD, so the trader sets aside a portion of his trading capital to purchase 100 shares of the underlying.
As a basic example, if a trader sold a cash secured January 133 put the trader would be required to have the appropriate cash in the account to purchase 100 shares of GLD at $133/share. So in order to have the put totally secured, the trader in this example would need $13,300 to fulfill the required capital obligation. For a more speculative trader that was looking to collect option premium based solely on time decay (Theta) and had no intention of owning common stock, margin encumbrance would be required. Most option brokers will demand that option traders be able to post 15-20% of the total obligation (Reg T) and will allow more experienced option traders to use margin in order to cover the remaining portion. Traders using portfolio margin can use this strategy to add income to their portfolio without tying up a significant portion of their trading capital.
Based on the weekly chart listed above, the target support areas are around $133/share and $130/share respectively. We will assume the trader wanted to purchase 100 shares at each price point. The trader in this example could sell 1 GLD January 133 Put and 1 GLD January 130 Put. Based on current prices, the trader would receive a credit of $235 for the GLD January 133 Put and a credit of $139 for the GLD January 130 put. Total credit on this trade would be around $374 not including commissions. If GLD does not sell off and continues to rally, the trader has the potential to collect a large portion of option premium from the two cash secured puts that he sold. In this case, the maximum gain would be the total credit received of $374 at expiration if the trader did not get assigned GLD common stock.
It is critically important to understand that there is significant risk in this trade as the theoretical loss would be over $26,000 assuming that GLD were to go to 0 and the trader did not close out the position. Clearly gold is not likely to be worthless, and the odds of losing $26,000 are slim to none however it is theoretically possible. If the trader in the example gets assigned the stock he still gets to keep the option premium for which he sold the puts for which was $374. Since he was purchasing 200 shares of GLD, his total cost would be reduced by $1.87 a share (374 / 200 = 1.87). The average price he would pay for 200 shares of stock would be $131.50/share (133+130 / 2 = 131.50), thus his actual price per share would be $129.63 (131.50 – 1.87 = 129.63).
The profit engine for the naked puts is time decay (Theta). Volatility and price risk exist and would become reality if a massive overnight sell off in gold took place. However, if the trade operated as is custom in traditional market conditions the option trader in this case either will earn a portion or potentially all of the premium he received for selling the puts or he will be assigned 200 shares of GLD with a total basis of $129.63. If the trader wishes to own 200 shares of GLD and has the capital to purchase the common stock, this is an excellent way to develop a trading plan that takes advantage of support levels and remains profitable if GLD continues higher.
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Security of Supply
Richard (Rick) Mills
Ahead of the Herd
As a general rule, the most successful man in life is the man who has the best information
While working for Shell Oil during the 1940’s Dr. M. King Hubbert noticed the production of crude oil from individual oil fields plotted a normal bell shaped curve. Roughly half of the oil from a field has been exhausted when the bell curve peaks.
Carrying that insight further he surmised that oil production from a group of oil fields would follow a similar bell shaped pattern.
In 1956 Dr. Hubbert predicted the cumulative group of oil fields within the US would reach peak production in the 1970’s, and thereafter decline – no matter how much money would be thrown at exploration and development of reserves US oil production would not rise higher after this date – his prediction was uncannily accurate.
There are a few things we can learn from studying oil production on the upside slope of Hubbert’s bell curve.
As oil production nears its peak:
- Oil becomes harder to find
- Discoveries are smaller and in less accessible regions or geologic formations
- Costs are higher to produce the crude from these discoveries
- Producing oil from existing fields becomes more expensive – recovering the last barrel of oil is more expensive than recovering the first barrel
Mine production of many metals is showing a number of similarities:
- Slowing production and dwindling reserves at many of the world’s largest mines
- The pace of new elephant-sized discoveries has decreased in the mining industry
- All the oz’s or pounds are never recovered from a mine – they simply becomes too expensive to recover
There are a few differences between mining and oil:
- Mining is more cyclical than oil which make mining companies even more reluctant than oil companies to spend on exploration and development
- There is no substitute for many metals except other metals – plastic piping is one exception. For oil substitution you have shale gas, coal liquefaction, nuclear power, oil sands, ethanol or bio-diesel, solar, geothermal and wind
- Metal markets are much smaller than the crude oil market so speculation is a larger factor
- There hasn’t been a new technology shift in mining for decades – heap leach and open pit mining come to mind but they are both decades old innovation. Oil producers have exploited new drilling and production technology to produce oil and gas from new types of reserves – oil sands and gas shales.
Increasingly we will see falling average grades being mined, mines becoming deeper, more remote and come with increased political risk. Extraction of metals from the mined ore will become increasingly more complex and expensive, even more so when one considers the effects of Peak Oil – the cost of technology innovation to power mining will be very high.
This is our reality – we’re living on a relatively small planet with a finite amount of reserves and a growing human population.
Broad spectrum peak commodities is a cause for concern over the longer term.
In the shorter to medium term there are several concerns in regards to global resource extraction we need to consider.
During the economic downturn miners saved their cash and paid off debt. Capital Expenditures were virtually non-existent and many projects were delayed or cancelled outright.
Below are five examples of production shortfalls looming or already existing:
“Operational constraints and cutbacks initiated in 2009 are projected to constrain mine production to 16.2 million tonnes in 2010. Looking to 2011, increased economic activity is expected to boost end-user demand for the metal much faster than production, pushing the global market deeper into deficit of about 400,000 tonnes. International Copper Study Group (ICSG)
“Short of silver mines with strong zinc/lead by-product credits there is nothing between here and the horizon in terms of new production. This then implies that a shortage bubble is coming along and prices will spike again as they did in 2006/2007. Primary base metal sources of Zn/Pb will be heading down as mines expire and no new production appears. This is where the real crisis is brewing.” Christopher Ecclestone, Hallgarten & Company
Rare Earth Elements
In the last 10 years the global market for rare earth elements has grown to 125,000 tons per year and by 2014 demand is predicted to reach 200,000 tons per year. China, the supplier of 97 percent of this demand is lowering export quotas and might very well stop all REE exports by 2014.
Today, there are some 441 nuclear power reactors operating in 30 countries. These 441 reactors, with combined capacity of over 376 Gigawatts (One GWe equals one billion watts or one thousand megawatts), require 69,000 tonnes of uranium oxide (U3O8).
According to the World Nuclear Association, about 58 power reactors are currently being constructed in 14 countries. In all there are over 148 power reactors planned and 331 more proposed. Each GWe of increased capacity will require about 195 tU per year of extra mine production – three times this for the first fuel load. Let’s also consider the fact that no one builds a $4 to $6-billion dollar reactor just to watch it go idle. They will order one or perhaps several year’s worth of fuel supply to guarantee it doesn’t.
In 2008, mines supplied 51,600 tonnes of uranium oxide concentrate containing 43,853 tU, which means mining supplied roughly 75% of nuclear utility power requirements. The remaining supply deficit used to be made up from stockpiled uranium held by nuclear power utilities, but their stockpiles are pretty much depleted. Mine production is now primarily supplemented by ex-military material – the Megatons to Megawatts program which ends in 2013 – the Russians have stated that the agreement will not be renewed.
Job Crisis in the Resource Extraction Sector
A combination of mass retirements and increasing natural resources demand from emerging economies has created a crisis in the resource extraction sector – one which is definitely not on investor’s radar screens.
The Mining Industry Human Resources Council (MIHRC) estimates that over 60,000 people employed in the mining sector are expected to retire by 2020 but that the industry will need an additional 100,000 people just to maintain current levels of production.
The Petroleum Human Resources Council of Canada warned a severe oil patch labor shortage is looming and that the “patch” will need to hire 24,000 new employees by 2014.
In both industries the biggest demands will be for workers to replace staff who reach retirement age.
The existing shortage of skilled personnel and the imminent retirement of so many baby boomers (many are mid level managers) means the mining sector is in direct competition with the energy sector for people to train and prospects are bleak for either industry to obtain the necessary bodies and minds.
One of the most serious and unpredictable risks facing mining operations and investor interests is “country risk” – where the political and economic stability of the host country is questionable and abrupt changes in the business environment could adversely affect profits or the value of the company’s assets.
Resource extraction companies, because the number of discoveries was falling and existing deposits were being quickly depleted, have had to diversify away from the traditional geo-politically safe producing countries. The move out of these “safe haven” countries has exposed investors to a lot of additional risk.
Many countries might come to mind as places where shareholders could, without warning, receive news that their operations have been taken over by the government and/or its friends, or that permits are suddenly suffering delays or have been cancelled outright.
JPMorgan Chase & Co. has bought 50 percent of copper stockpiles in London warehouses. The purchase, reported in the Wall Street Journal, takes place as new exchange traded funds focused on copper come to market.
The ETFs are expected to put further pressure on already tight copper supplies.
“It’s another new element of demand for copper in an already tight market.” said Patricia Mohr, commodity market specialist at Scotiabank
Security of Supply
Access to raw materials at competitive prices has become essential to the functioning of all industrialized economies. As we move forward developing and developed countries will, with their:
- Massive population booms
- Infrastructure build out and urbanization plans
- Modernization programs for existing, tired and worn out infrastructure
Continue to place extraordinary demands on our ability to access and distribute the planets natural resources.
Threats to access and distribution of these commodities could include:
- Political instability of supplier countries
- The manipulation of supplies
- The competition over supplies
- Attacks on supply infrastructure
- Accidents and natural disasters
- Climate change
Accessing a sustainable, and secure, supply of raw materials is going to become the number one priority for all countries. Increasingly we are going to see countries ensuring their own industries have first rights of access to internally produced commodities and they will look for such privileged access from other countries.
Numerous countries are taking steps to safeguard their own supply by:
- Stopping or slowing the export of natural resources
- Shutting down traditional supply markets
- Buying companies for their deposits
- Project finance tied to off take agreements*
*Traditional sources of project finance have mostly dried up or are on terms that are unacceptable. Project finance is largely provided by developing nations and is usually being tied to off take agreements.
“As the potential for commodity scarcity escalates, M&A activity in the global mining sector will likely intensify, mimicking a ‘global arms race.” M&A in the Global Mining Sector – No Stone Unturned, PricewaterhouseCoopers
Every country needs to secure supplies of needed commodities at competitive prices yet supply is constrained and demand is growing. Barring a total global economic collapse or a dramatic reduction in the worlds human population it doesn’t seem to this author demand is going to collapse anytime soon.
The International Monetary Fund (IMF) recently published its report World Economic Outlook for October 2010 and in it they talked about commodity demand from emerging countries. “Because their growth is more commodity-intensive than that of advanced economies, the rapid increase in demand for commodities over the past decade is set to continue…the current era of higher scarcity, rising metal price trends and a balance of price risks tilted toward the upside may continue for some time.”
This author believes that there is exceptional, and as of yet, undiscovered value in junior companies with quality assets in safe stable countries.
Junior resource companies offer the greatest leverage to increased demand and rising prices for commodities.
The bottom line for investors in the resource sector is that juniors already own, and find, what the world’s mining companies and refineries need.
Are there a few junior resource companies, with exceptional management teams, on your radar screen?
If not maybe there should be.
If you’re interested in learning more about the junior resource market please come and visit us at www.aheadoftheherd.com.
Membership is free, no credit card or personal information is asked for.
Richard is host of www.aheadoftheherd.com and invests in the junior resource sector. His articles have been published on over 200 websites, including: Wall Street Journal, SafeHaven, Market Oracle, USAToday, National Post, Stockhouse, Lewrockwell.com, Casey Research, 24hgold, Vancouver Sun, SilverBearCafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Calgary Herald, Resource Investor and Financial Sense.
Legal Notice / Disclaimer
This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Richard Mills has based this document on information obtained from sources he believes to be reliable but which has not been independently verified; Richard Mills makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Richard Mills only and are subject to change without notice. Richard Mills assumes no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, I, Richard Mills, assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information provided within this Report.
Richard Mills does not own shares of any company mentioned in this report
No company mentioned in this report is an advertiser on Richard’s website www.aheadoftheherd.com.
The SP 500 and Gold are in the last stages of the rally from July
David Banister- www.markettrendforecast.com Dec 5th 2010
The Elliott Wave patterns that I use to forecast movements ahead of time in the SP 500 and Gold for my subscribers have been textbook perfect for quite some time. We can go back to the March 2009 lows and clearly identify 5 waves up to the 13 month initial rally high in April of this year. This was followed by a clear ABC wave 2 pattern to the 1010 lows on July 1st. Right now, the SP 500 is in wave 5 up since July 1st, and that means this is a terminal wave underway before a good sized correction ensues.
Investors should expect the SP 500 to rally up to 1285 as a minimal upside target, with the market likely peaking in the Mid January 2011 period prior to a new correction pattern. That correction will take the markets down to the 1150-1180 ranges more than likely from the January highs and knock the sentiment levels back to bearish before the next big advance. Below is where I see the current wave patterns, and as you can see, this is the 5th and final wave stage of the advance. Ride it up, but lighten up as we approach my figures is my advice. Subscribers to my TMTF service have been riding this stage of the bull long since early July, and we keep them updated every week on the action.
Gold has also completed it’s 4th wave corrective pattern at $1331 per ounce recently, and as I have forecasted recently should continue it’s upward trajectory to about $1480-$1525 before a good sized correction will ensue. Gold bottomed this summer in a classic wave 2 correction at $1155 per ounce, which was a 50% Fibonacci re-tracement of the rally up to $1225 from $1040. My objectives are for this pattern to complete around the same time as the SP 500 peak in Mid January as well. Downside objectives from there are likely to be to the $1310 per ounce range from the $1480-$1525 peaks, but more on that as we approach. I do not like to get too far ahead of myself in my projections, taking it one leg and pivot at a time.
If you’d like to be consistently ahead of the major market and precious metals moves and profit from that positioning, then consider subscribing today. Visit www.markettrendforecast.com for the details and a coupon to subscribe.
Sellers were in control most of the trading session on Tuesday, however an overnight buying surge pushed the S&P 500 back up to overhead resistance as the directional battle raged on between the bulls and the bears. For over a week we have had relatively choppy trading as the S&P 500 has remained in a tight range between the 20 and 50 period moving averages. By the open Wednesday, the U.S. financial markets demonstrated their resiliency yet again. It is critical to note that we received our first and second official tests of the 50 period moving average on the S&P 500 daily chart.
While recent analysis has offered that prices are consolidating and that a significant move is likely to play out, it is too early to be making market prognostications about what is to come. However, the S&P 500 is leaving us with a few clues about potential direction which is apparent through the lens of technical analysis. While the 50 period moving average was tested both Monday and Tuesday, price action early Wednesday morning was extremely bullish on the heals of a solid ADP employment report and a slight pullback in the U.S. Dollar. As stated in my previous analysis, we will remain in a technical uptrend until we get sustained prices below the 50 period moving average on the daily chart of the S&P 500.
As most veteran traders realize, key price levels weaken each time they are tested until eventually they break. Time and price will line up and we will either have a strong sell-off, or the equities market will bounce and test the recent highs. Now that we have had a second test of the 50 period moving average, the 3rd test may see the support level give way to lower prices. If prices break below recent support and we lose the 50 period moving average, it is likely price will correct to the S&P 1150 level with the possibility of testing the 200 period moving average. In contrast, should the S&P 500 price breakout over recent resistance we could challenge new highs. At this point in time, price action should be monitored closely to see how the S&P 500 handles these key levels.
Gold and silver had strong advances higher on Monday and Tuesday with the U.S. Dollar continuing its rally. While not a frequent occurrence, a simultaneous rally in the U.S. Dollar and precious metals is typically the result of abnormal market conditions. The crisis unfolding in Europe was likely the force behind the mutual rally in precious metals and the U.S. Dollar as central bankers and asset managers fled the Euro seeking safe havens. The dollar continues to sustain bullish price action and has the potential to go much higher than many traders and money managers may expect.
Gold and silver have had monster sized runs and appear to be consolidating before making their next move. While the ominous head-and-shoulders pattern is apparent on GLD’s daily chart, the potentially more negative aspect regarding the metals is their widespread acceptance as a safe investment by the retail crowd. While gold and silver could continue higher, at some point it would be healthy to see a pullback and with so many retail investors long gold and silver, a strong correction would wash out emotional bullish traders before ultimately heading higher.
At this point, I am sitting back and watching the price action unfold, but should the neckline of the head and shoulders pattern break to the downside, I will likely get involved with some downside exposure.
U.S. banks have been under pressure as a variety of headwinds faces the sector. Most of the banking concerns of which traders are aware are increased regulation, foreclosure nightmares, capital formation issues, and commercial real estate and development problems. Has anyone given any thought to whether U.S. Banks have any exposure to the European banking/sovereign fallout? It is without question there is exposure, the more appropriate question should be who is exposed, and how much risk did they take on? Since we will likely not prospectively know who is exposed until price action confirms their identity, the safest way to play that potential risk is through the financial ETF XLF.
Through the use of this ETF, traders can broaden their horizon and focus more on the price action without worrying about which specific banks are exposed to heightened risk. XLF has already broken down below its 50 period moving average on the daily chart. While a bounce is likely, if the 50 or 20 period moving average hold XLF down, it is likely we will see prices roll over and XLF could potentially challenge new lows. Should this take place, the S&P 500 will likely follow in the XLF’s footsteps.
Traders moved oil prices higher on Monday, but Tuesday saw market participants take profits and push USO lower by the closing bell. USO, much like gold and silver is a mixed bag when looking at the daily chart. On one hand, we can see that Monday’s action pushed prices above the 20 period moving average. During intra-day trading on Tuesday, price tested the 20 period moving average and support held firm. Wednesday morning energy traders pushed oil higher, but as of the writing of this article oil was trading at resistance. While there are clearly bullish signals on the USO daily chart, USO appears to be forming a head and shoulders pattern similar to gold. With conflicting technical information, sitting on the sidelines and waiting for price and direction to be confirmed is likely a sound decision, at least that is the way I am playing it.
Goldman Sachs (GS) is offering two interesting trading setups that option traders could use which have a different directional bias. The daily chart places Goldman in a descending channel and provides traders who want to get short with defined risk. Those who remain bullish could get long and use the 50 period moving average as a stop. At this stage in the December option expiration cycle, utilizing time decay (Theta) as either a profit engine or a way to reduce the cost of a spread is a sound trading strategy.
With less than 3 weeks until expiration, time decay (Theta) accelerates rapidly on its inevitable path to 0 at expiration. This process increases dramatically the final two weeks leading up to expiration. Option traders that utilize time decay (Theta) to reduce the cost of a spread or as the primary profit engine of a trade construction (credit trades) are capitalizing on an inevitability.
Clearly there are inherent risks such as an increase in implied volatility, but without question at option expiration the time value of options will be reduced to 0. Time decay (Theta) and implied volatility are the two most likely culprits as to why novice option traders consistently lose money trading options. Understanding a few basic principles regarding option Greeks is critical in order to produce profits. The daily chart of Goldman Sachs is shown below.
Those who are bullish with regard to Goldman Sachs could use a call vertical (bull call spread) with the following strikes:
Long 1 December 160 Call Contract
Short 1 December 165 Call Contract
Through the use of a hard stop well below the 50 period moving average, an option trader could define his risk while having a quality risk / reward trade. The maximum loss on this trade would be less than $180 per leg while the maximum gain would be slightly over $320 not including commissions as of Wednesday morning. The use of a hard stop would reduce risk further and could potentially lead to a nice profit in days to come.
For traders who want to press the downside, a put vertical (bear put spread) could be used with a contingent stop around the $161/share price level. The trading setup is as follows:
Long 1 December 160 Put Contract
Short 1 December 155 Put Contract
The maximum loss per side for this trade would be around $230 while the maximum gain is $270 as of the Wednesday morning. Similarly to the call vertical spread listed above, the use of the contingent stop reduces the intra-day risk even further. While these setups are about as basic as it gets regarding option trading, they can really produce some nice profits. Again, these are not recommendations, but simply an example of the profitability that options can add to your trading if they are used appropriately.
In closing, we are seeing a lot of head and shoulders patterns developing in a variety of trading vehicles. While these patterns can mean substantial downside is ahead, there is always the potential that they could fail. Failed patterns result in fast, potentially devastating moves. If the head and shoulders patterns we are seeing in the S&P 500, gold, and oil fail a fast paced rally will likely unfold. In contrast, if the patterns play out a nasty sell-off could take place. At this point in time, a significant move is likely to unfold, but as usual which direction prices will eventually go remains unknown.
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